Divergence in rules and enforcement

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The inconsistency of treatment among the different tax authorities regarding the relevant exit tax position on transfers of value through the commercial business restructurings has presented a challenge to MNCs.

The OECD published Chapter IX of the Transfer Pricing Guidelines on 22 July 2010. The guidelines define a business restructuring in a relatively broad way, as a “cross-border re-deployment by a multinational enterprise of functions, assets and/or risks,” which in essence, covers any substantial change to an existing business relationship. This can include a change in the scope or nature of a transaction, a change in the allocation of risks, a shift in functional responsibility or the termination of a relationship.

Main implications of Chapter IX of the Transfer Pricing Guidelines

By publishing the guidance, the OECD is endorsing the view that business restructuring does happen in practice.

The arm’s length principle does not apply differently in the case of a business restructuring than in any other transfer pricing context.

Proving the arm’s length nature of a business restructuring programme does not require evidence of unrelated parties engaging in similar programmes, i.e. the arm’s length nature of the business restructuring arrangements should be analysed on their own terms, using the arm’s length standard.

Tax authorities may challenge the contractual allocation of risks if that allocation is not at arm’s length, seeking pricing adjustments or in extreme cases recharacterisation, or further if the conduct of the parties does not follow the legal agreement outlining the risk allocation.

The loss of profit to the restructured entity (that loses functionality or bears fewer risks) does not in itself, provide a basis for a compensation payment. However, compensation payments may be appropriate when there is a transfer of assets or a termination or substantial change to existing transactions and a payment would also have been made between uncontrolled parties.

Arm’s length compensation should ensure that both parties are at least as well off as they would have been if they had pursued other realistically available options, including the option not to restructure.

Complying with the guidance requires keeping comprehensive documentation regarding the restructuring including a ‘before and after’ functional analysis.

The issue of inconsistency

The factors below all heighten the risks of double taxation and protracted tax disputes.

Many jurisdictions in Asia-Pacific are not OECD members and do not have legislation requiring the application of the OECD guidelines in reviewing taxpayer affairs.

Many countries in Asia-Pacific follow the United Nations model rather than the OECD model, adding another layer of complexity and variance in the interpretation of tax treatment and taxing rights.

Tax authorities are still developing their own specific views on the broader question of how best to enforce arm’s-length business restructuring activity and develop audit capability.

Many regional authorities do not have APA programmes. Those that do have been reluctant to rule on business restructuring issues concerning exit charges in their APA programme.

Many regional tax authorities have developed their own principles to deal with transfer pricing approaches to business restructuring and exit charges thereon.

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